Cash Management in CMBS: Did you know?

What is Cash Management, and How Can You Prevent it From Causing You Harm?

by Shlomo Chopp, Managing Partner

Traditional bank loans have very conservative underwriting standards, while structured finance loans, such as CMBS, are often willing to take more upfront risk as long as certain credit enhancements are in place.

A classic example of a credit enhancement is a lockbox (or cash management account), where the lender has contractual control over the property’s cash. This setup ensures that if there’s any distress, funds are applied according to the terms. However, handing your lender control over the financial flow of your property can be tricky—especially if you don’t fully understand what you lawyer or mortgage agreed to and you signed without reviewing.

The issue with the cash management structure isn’t its existence, but rather borrower preparedness, liquidity, and the cash-grab mentality of some servicers (who may find every reason not to release cash to borrowers). The fear around cash management is so great that I’ve often seen borrowers intentionally default on loan documents to avoid implementing a lockbox - a compounding disaster that will often trigger full recourse.

Let’s dive deeper into how a lockbox/cash management works. (This isn’t intended to be all-inclusive)

When you take almost any commercial mortgage, you sign an assignment of leases and rents, which pledges all leases and rents to the lender. In exchange, the lender allows you to benefit from the property’s cash flow—provided the loan is current. However, with structured finance loans, the lender might set up a series of accounts, even on day one, to ensure cash flow is allocated as required under the loan documents.

The first element in the cash management structure is a lockbox. At loan closing (or after a trigger event), the borrower directs tenants to deposit rent into this account. If a cash management trigger occurs, funds are swept multiple times per week into a “cash management account.” From here, funds are allocated according to a “waterfall” structure.

Similar to a natural waterfall flowing over a series of rocks, funds are applied to priority expenses in sequence. Typically, funds first go towards property taxes and insurance escrows, then to interest, then to leasing and capital reserves. Any remaining cash flow goes to operating expenses, based on a borrower-submitted budget, and any extraordinary expenses as requested by the borrower. Finally, if there’s no cash trap in place, any leftover funds are released to the borrower.

Sounds simple? It’s not. Most loans have a payment date of the 6th of the month. If funds arrive on the 7th, they won’t apply for that month unless the servicer makes an exception. This means if a tenant pays late and there aren’t enough funds to cover the mortgage payment, the borrower has to make up the difference temporarily.

But wait, there’s more.

Many loan documents specify a “collection period” — the period during which funds must be received. This often ends a day before the payment due date. So, funds received on the payment date may not be eligible for that period’s payment. Things get even more complex when, for example, July 6 (if the payment is the 6th of the month) falls on a weekend - like it did this year. In the below screenshots, you will find examples of this exact scenario - and email from a servicer. When July 6 was a weekend, the pay date moved to July 5. This meant the collection period ended on July 3, since July 4 was a holiday. All funds had to be deposited by July 3 to meet the waterfall requirements. If rent came in on the 5th, it was ineligible to be applied towards the mortgage payment.

Email 1: We have your money, but it cant be used. Send more!

Email 2: The loan document and servicing debate

Email 3: Nah, no admission coming from us

Is your head spinning yet?

I haven’t even covered cash traps or bespoke leasing reserve accounts.

Here’s another twist—many loan documents require that even if the cash management account has sufficient funds to cover the monthly payment, the borrower must still deposit any operating expense shortfalls into the lockbox. Then, the lender, as long as there’s no event of default, will then release those funds back for operating expenses. Not depositing those funds would mean that there was insufficient funds to “run the waterfall” and the loan may end up in default and miss a payment - unless funds were specifically sent in to cover the payment. This is because once the pay date passes, the funds in the cash management account must be applied to the next months waterfall - and yes, there will be excess cash - unless the default triggers a cash trap (and the monies are swept into a separate account - until the cash trap termination event occurs - don’t ask…)!!

I’ve said it before, and I’ll say it again: you can never pay too much for the right loan document lawyer, and most small borrowers should steer clear of CMBS. It’s simply not designed for them.